Renewed interest in real estate investment in Russia and new legislation governing town planning is seeing the market – and the country’s dilapidated residential housing – receive a facelift.

It is not news that Russia is still topping the polls as the most attractive destination for real estate investment funds in Europe. Real estate investment in Russia increased by more than 1,000 per cent last year, according to real estate management company Jones Lang LaSalle.

All sectors are doing very well, particularly warehousing and retail. Cushman & Wakefield reported in November 2006 that a record 13.8 million square metres of new shopping centre schemes are due to open across Europe this year and that Russia is top of the table for shopping centre developments.

Infrastructure is also benefiting from investor interest, but bearing in mind the poor quality of Russian infrastructure, there are still plenty of opportunities for investors prepared to take a long view and carry the risk, as those involved in the new highway planned between Moscow and St Petersburg using a PPP structure are doing.

What is new is that changes in Russian law aim to stimulate foreign investment in the most difficult section for foreign investors, and the most opaque – residential property.

The new federal law on the amendment of the Russian Town Planning Code of the Russian Federation of 18 December 2006 (Law 232) ushers in a raft of changes in the biggest recent shake-up of residential property law.

Land registration

Unlike common law legal systems, in Russia there is only residential and non-residential property. Therefore warehouses, retail, infrastructure and other uses of property fall under the non-residential laws and regulations, which differ from those under the residential real estate system.

There is also little privately owned land in Russia. The state or municipal bodies (in many instances it is not clear which) own almost all the land in Russia. Traditionally state or municipal authorities do not register their title to land even when it is clear which state authority is entitled to the land. Although the 1998 registration law stated that all transactions involving titles of land and property have to be registered, pending registration of title local authorities have been able to dispose of land via granting leaseholds.

Furthermore, land and buildings located on such land are treated separately and the ownership of the land usually follows the ownership of the associated buildings on it.

The need for legislative change to fuel investment in residential property had become urgent by last year for a very practical reason. A construction boom in the 1960s in Russia created many swathes of five-storey housing estates that have not stood the test of time. They urgently need to be replaced with housing befitting the 21st century. There is also a great need for investment in older, dilapidated residential housing, which is often located in prime city sites. Making residential housing more attractive for investors is the reason for these new laws.

Extensive regeneration

The new regime introduces a new concept of comprehensive development of existing residential areas. This type of development may include renovation of existing houses and, most significantly, new construction. This is exactly what is required for investors.

In particular, the new law provides that districts may now be developed pursuant to a contract concluded between the investor and the local authorities following an open, transparent tender. The essential terms and conditions of such contracts are set out in the Town Planning Code.

The contracts will require the investor to prepare at its own expense a draft plan demarcation of the territory and its zoning; to transfer into state or municipal ownership residential premises for the relocation of residents of existing houses rented from the authorities and to buy out the existing owners of privatised flats and apartments.

Investors interested in participating in such projects still need to be willing to bear significant costs and expenses, some of which should not necessarily be borne by a private investor.

This should not put investors off, though. The local authorities’ obligation to grant to an investor lease rights over publicly owned land, within the territory to be developed and without a tender, may give developers some comfort. This means that only one tender will be held. The winner will be given the right to enter into a contract for the comprehensive development of a territory, which may in fact consist of several land parcels. Previously separate development of these parcels would involve separate tenders.

Tackling illegal development

Another change will be a crackdown on corruption. Quite often developers have obtained the rights to develop residential sites without a transparent and legally clear tender and the sector had a reputation for being too opaque.

Governmental agency the Federal Antimonopoly Service (FAS) is already showing it intends to fight corruption in this sector; there are already reports in the Russian press that it has issued a warning notice to a major local Moscow developer who is alleged to have obtained the right to develop a prime residential site in central Moscow without a transparent tender process.

The construction permit process has been improved. A single state assessment of construction and design documentation will replace a bewildering array of separate expert assessments, including those previously carried out individually by public health, fire, environmental, historical monument conservation and other authorities.

Local authorities frequently lack sufficient resources and staff to cope with the increased volume of documentation submitted for review, but unlike the previous regime the granting of a construction permit should certainly take less than a year.

Mortgage rights

The demand for residential property has been given a significant boost. The Mortgage Law 1998 is amended so that mortgages of land plots to which state freehold ownership is not determined and registered in the Consolidated State Register of Rights can be legally valid in the absence of such registration.

The idea that you can have a mortgage on land that does not have a defined freeholder is not one that Western investors initially find comfortable. However, if you accept that the freehold is owned simply by a public body then it is easier to understand.

The conditions under which the mortgage can be effected include the property being designated for housing construction or initial preparatory works for subsequent complex housing development or if the property is to be used as collateral to secure bank loan financing. This change will help raise financing for local as well as foreign investment in foreign housing development projects. Furthermore, if after three years no building or construction work has been commissioned, the landlord, the publicly owned body, can terminate the land lease.

Four months have passed since the new laws were passed. However, developers are already proving happier to consider early stage development of residential property as a result of these changes. While good laws can be ruined at the implementation stage, currently it seems that these legal developments can only support and sustain the prominence of Russia as the most attractive European country for real estate investors.